California intermediate appellate court holds that offer was not bona fide. The earnout disqualified the offered purchase price from being “in a dollar amount.”
M&A Stories
August 09, 2021
Introduction:
When purchasing a business from a franchisee, there are additional complexities due to the involvement of both the seller and the franchisor. The rights of the franchisor in a franchise acquisition are defined in the franchise agreement, which governs the relationship between the seller and the franchisor.
The Deal:
In this case, a franchisor owned and operated dating and matchmaking service franchises. A franchisee in San Francisco wanted to sell its business to a third-party buyer. The buyer, who already operated similar franchises, offered $1,460,000 for the purchase, with $1,314,000 being an earnout contingent on future revenues.
The Franchise Agreement and Lawsuit:
As per the franchise agreement, the franchisor had the right of first refusal and could substitute itself as the purchaser at the same price and terms. To be considered a valid offer, the proposed purchase price had to be a specific dollar amount. The franchisor chose to exercise its right of first refusal, leading to a legal dispute.
Court’s Decision:
The case went to a California state court, and the appellate court ruled that the buyer’s offer was not bona fide under the franchise agreement. The court considered the earnout part of the purchase price as not meeting the requirement of being “in a dollar amount” as specified in the agreement.
This case is referred to as JLSF, LLC v. It’s Just Lunch International, LLC, No. E071940, Court of Appeals of California, Fourth District, Division Two, (Filed July 16, 2021).
Comment:
Franchisee sellers must carefully review their franchise agreements to ensure that the sale structure aligns with the agreement’s terms. In this case, an earnout purchase price was deemed invalid, highlighting the importance of understanding the agreement’s provisions before entering into a sale agreement.
By John McCauley: I help people manage M&A legal risks.
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